By Roger J Kerr*
The headline for last week’s commentary piece was that the Kiwi dollar had stopped depreciating at 0.6500, however a positive was needed to turn the sentiment around and start a recovery against the USD.
The NZ GDP growth numbers for the June quarter (not the Government financial accounts Jacinda!) provided that turnaround catalyst, with a stellar 1.00% expansion and the Kiwi rocketed up over one cent to 0.6700 as a consequence.
There will always be a significant reaction in the currency markets to economic performance numbers that are so far above prior expectations (consensus forecasts beforehand were around +0.70%).
What was particularly encouraging from the detail of the GDP figures was that the growth was across the board of nearly all industry sectors, services being a standout lift.
There were no major one-off variables or inventory increases that could reverse out next quarter.
The continuation of the strong GDP growth performance in 2018 does not necessarily make a mockery of the very pessimistic business confidence surveys. The uncertainties that business folk are reflecting in answering the survey questions on the general economy and their own business outlook is all about Government-signalled changes to taxation and collective workplace wage/conditions agreements in the future.
The reality is that low business confidence results mostly influence business investment decisions and if investment/output eventually reduces, GDP growth will slow up.
However, these changes do not happen overnight and it may take until 2019 for the economy to slow if the business sentiment remains so negative. The ball is in the Labour Coalition Government’s court to restore the relationship with and confidence of the business sector by watering down some of these signposted and extreme economic policy shifts.
The ball is also firmly in the court of the RBNZ to re-examine rather closely their economic forecasting model as their GDP growth forecast for the June quarter (+0.50%) was precisely half the actual outcome!
A continuing positive for the Kiwi dollar from the stronger than expected GDP growth result will be a revision upwards in the RBNZ’s inflation forecasts for the next 18 months.
It will be interesting to see if Governor Adrian Orr changes his wording or inferences in this week’s OCR review statement. It is positive for the Kiwi dollar if the RBNZ are forced by the stronger economic data to increase their inflation forecasts and bring forward the timing of the first OCR increase (having just pushed it out further a month ago).
The Reserve Bank of Australia are stating that their next OCR move will be upwards. In contrast, the RBNZ appears to be giving equal waiting to a move up and a move down.
Given the the positive momentum in the rural economy right now (forestry, fishing, dairy, beef, sheepmeat, horticulture, wine and Aucklanders selling up their houses and shifting south), there is a real risk that the RBNZ have made a misjudgement on the economy and inflation. Therefore, sometime before the end of 2018 they will be forced to change their tune.
It is not unreasonable to expect to see the Kiwi dollar appreciating another two cents just on the back of this potential RBNZ flip-flop alone.
CPI inflation numbers for the September and December quarters, released in mid-October and mid-January respectively, will be key indicators as to how the lower currency value, higher wage settlements, higher fuel prices and less imported deflation are transferring through into general inflation.
Whilst not a perfect correlation between NZ GDP growth and the NZD/USD exchange rate, the chart below does support the view that the Kiwi dollar at 0.6700 against the USD would still have to be considered undervalued on economic fundamental grounds.
The loose correlation broke down in 2014/2015 when dairy prices collapsed and the Kiwi dollar went down as GDP growth increased due to other industry sectors going gangbusters and compensated out the dairy downturn.
The outstanding GDP growth number will also act as a catalyst to prompt the offshore speculators to reverse their weighty “short-sold NZD” positions and take their profits before the Kiwi rises any further and those profits are eroded away. The speculators will be the Kiwi dollar buyers that send it higher over coming weeks.
Adding to the NZ dollar’s turn-around in sentiment and direction is how the global financial and investment markets are now interpreting the escalating trade war between China and the US.
Up until last week, the FX markets reaction to an increase in tariffs and tensions was to buy the USD against the Euro. However, a change has occurred with the USD weakening over this last week to nearly $1.1800 against the Euro, even though President Trump upped the ante on the Chinese with more tariffs and the Chinese cancelled planned trade talks.
My reading of this change in treatment by the FX markets is that they have now realised that a full-out trade war is not good for the US economy and thus not a USD positive.
Any slowdown in US economic growth in 2019 as a result of Trump’s tariffs will make his Government’s budget deficit even larger than what it is already going to balloon out to (6% to 7% of GDP). Thus a very large negative for the US dollar’s value. Potential political risk for Trump surrounding the November mid-term elections in the US is also a US dollar negative factor coming up.
The forward looking scenario I expect for the NZD/USD over the next 12 months is a stronger Kiwi to 0.7000/0.7200 on a weaker USD, RBNZ stance shift and re-alignment with the higher commodity prices over the next six to nine months. After that, there is a risk of a pull-back to marginally below 0.7000 on a major global share market correction downwards and the “risk-off” investor sentiment is always something that pushes the Kiwi dollar down.
USD importers should continue to hold-off on any new hedging and allow hedged positions to reduce to policy minimums. USD exporters should now be forward hedged to the hilt of their policy maximums.
*Roger J Kerr is an independent treasury Management advisor. He has written commentaries on the NZ Dollar since 1981.